Evaluating Conventional vs. FHA (VA & USDA)

Choosing between conventional & FHA financing isn't always clear, there are many factors that need to be taken into consideration. Below I will go over a few points.

Conventional comes in two forms: conforming & non-conforming. Conforming means it meets Fannie Mae's & Freddie Mac's guidelines, non-conforming does not meet those two quasi-government company's guidelines. The most distinct difference is when you are financing a mortgage amount that exceeds the conforming loan limits. Conforming loan limits are $417,000 and can be higher in high cost markets (NYC, LA, SF, Boston, etc.), anything over the conforming loan limit is considered a non-conforming loan amount and thus needs non-conforming financing. Conforming financing is offered by pretty much any mortgage lender, non-conforming financing is tougher to find and by today's offerings the rates can be approximately 1-2% higher. These days conforming financing is split up between two categories as well, "regular conforming" and "conforming jumbo". The regular conforming loan programs are for loan amount of $417,000 and under, and the conforming jumbo programs are for those high cost areas which have higher conforming loan limits. Conforming jumbo guidelines are more restrictive in terms of credit score, down payment requirements and debt to income ratio. The difference between those two conforming sub-category rates is often between .25% to .50%.

FHA financing also has a maximum mortgage limit, in all areas it's at least $271,050, and then in higher cost areas it increases from there.

FHA loans have monthly mortgage insurance unless the term is 15 years or less and the loan-to-value is 90% or less. For terms longer than 15 years the amount of the mortgage insurance is .55% (.5% if the loan-to-value is 95% or less) of the base loan amount per year, for terms 15 years or less and loan-to-value over 90% it's .25% of the base loan amount per year, both are paid in monthly installments as a portion of the mortgage payment. The monthly mortgage insurance needs to be paid for at least 5 years and also until the loan amount reaches 78% of the home's value at the time the loan was made (not current value). Will you have mortgage insurance on the proposed conventional loan? If so, what is the rate of the mortgage insurance for the conventional loan?

FHA loans also have an upfront mortgage insurance premium (UFMIP) equal to 2.25% of the base loan amount, which can be paid out of pocket or financed into the loan amount (most people choose to finance it). So you should consider if you paid 2.25% in origination/discount points on a conventional loan - what would your interest rate be?

Usually if the loan-to-value is 80% or below, conventional financing wins out pretty much every time. There are exceptions, such as the situation with a lower FICO score (below 660) and loan-to-values between 70-80% where interest rates for conventional loans can become significantly higher than their FHA counterpart. But when considering the UFMIP that FHA charges conventional still has a slight advantage.

When loan-to-value is between 80-95%, and with strong (720+) FICO scores, conventional often is the better bet due to the competitive mortgage insurance rates vs. FHA, plus there is no UFMIP fee like there is with FHA. Loan-to-value between 80-95% with 660-719 scores, conventional starts to lose it's competitive edge since the mortgage insurance rates increase vs. FHA's. Above 95% loan-to-value FHA becomes the better choice due to the inability to obtain mortgage insurance with conventional financing.

FHA is also more lenient on imperfect credit, allowing collections/charge-offs to remain open/unpaid (this is up to lender discretion however), late payments on consumer debt (auto, credit cards, etc.), and even a mortgage late payment or two, whereas conventional financing may not approve spotty credit. This is particularly true when the loan-to-value is over 80% when conventional financing requires mortgage insurance, as the mortgage insurance provider also underwrites the loan in addition to the lender, and mortgage insurance underwriting guidelines are pretty strict (even more so than lender underwriting).

Lastly, FHA permits higher debt to income ratios than conventional financing does. So overall FHA is more lenient, but there are situations where a borrower does not need the leniency to get approved for a mortgage, and that is where conventional gains the edge.

When evaluating conventional vs. FHA it's good to get a payment breakdown along with a fee estimate, so you can see how the overall loan is affected.

Re: Evaluating Conventional vs. FHA

Also wanted to point out that VA & USDA, when available, are almost always a better option as there isn't any monthly mortgage insurance on either.

VA has a funding fee (similar to the upfront mortgage insurance premium that FHA has), first time use and less than 5% down is 2.15%, 5-9.99% down is a 1.5% funding fee, and 10% or more down is just a 1.25% funding fee. Subsequent use, no matter the LTV, is 3.3%. For a VA IRRRL (Interest Rate Reduction Rollover Loan) it's .5%, this is similar to an FHA streamline where it's easier qualifying in theory, however we are seeing some lenders add overlay guidelines. Reservists pay .25% more in funding fee's except for subsequent use & IRRRL's. Veteran's who had a service connected disability and also have a certain amount of disability rating can be exempt from having to pay any funding fees, and are often eligible for discounts/exemptions on property taxes as well.

VA is a good option when available and when putting less than 15% down. With 15% down or more, and FICO scores of 660 or higher, conventional starts gaining an advantage over VA since the mortgage insurance won't be much on conventional vs. the VA funding fee, and at 20% down conventional is almost always the better bet.

USDA Rural Development (RD) has two versions, a "Direct" program which is available to people who fall within the "low income" eligibility limits and the mortgage application is made directly to USDA, and the "Guaranteed" version which is available to people who fall within the "moderate income" eligibility limits. The properties also have to be in an eligible area. With the Guaranteed version, USDA charges a 3.5% guarantee fee (similar to FHA's upfront mortgage insurance & VA's funding fee) on purchases and 2.25% on refinances of existing USDA mortgages, currently these 3.5%/2.25% figures are what USDA is currently using even though they technically aren't official yet (this is what HR 4899 will put in place). Both the income limits & eligible areas can be found at http://eligibility.sc.egov.usda.gov/eligibility/welcomeAction.do.

The USDA RD mortgage is a "loan of last resort", meaning if you can't qualify for FHA or conventional they then want you to try USDA. The reason they say this may be for many reasons, but the primary reason I believe is that USDA's funds are limited so if everyone used USDA vs. FHA or conventional then the people who truly need USDA or couldn't buy a home wouldn't have the option unless the fiscal year starts over. They don't require you furnish an FHA or conventional loan denial in order to obtain USDA RD financing, but from what I've seen it just really means if you have 20% to put down then they are going to question why the use of USDA and most likely will decline. USDA RD's advantages/disadvantages vs. conventional & FHA financing are the same as VA's.

Re: Evaluating Conventional vs. FHA

"VA is a good option when available and when putting less than 15% down. With 15% down or more, and FICO scores of 660 or higher, conventional starts gaining an advantage over VA since the mortgage insurance won't be much on conventional vs. the VA funding fee, and at 20% down conventional is almost always the better bet."

Not sure that I agree with this...all VA bias aside.

Nearly every lender's VA rates are lower than conventional, usually by .25%. If a borrower puts 20% down on a Conventional and 20% down on a VA, even with the funding fee, the lower interest rate on the VA loan still results in a lower monthly payment. This can be increased even moreso if on the VA loan some of that 20% down payment is used instead to buy down the interest rate. For the same amount invested in the deal, VA wins.

Also, in this buyers market we are in, the flexibility VA offers in allowing sellers to pay any and all the buyers closing costs gives VA another clear advantage.

Re: Evaluating Conventional vs. FHA

Heya Steve, didn't know you posted here too. You make a good point, and thanks for adding that. It does get really close when comparing 15-20% down on VA vs. conventional. The FICO score would pretty much be the determining factor on what terms would be available for conventional. Given the difference in VA rates vs. conventional, and when 10% down or more (using VA funding fee of 1.25% for this comparison), it actually appears a 720 score would give borrowers approximately the same rate with conventional financing and paying the 1.25% towards buying the rate down, as they could obtain with VA.

Re: Evaluating Conventional vs. FHA (VA & USDA)

is it possible to qualify for fha without any active credit tradlines?

have an old collection that's showing in the year 2003 on a car that was repo and sold for market value.

neve went into debt after this. everything we bought was saved and paid in cash.

currently my score is 620 and spouse is 640. my income 1300 / hers 2100

thanks any advice will help..

If there is only negative trade lines on the credit report, without any positive trade lines, then typically lenders will not allow non-traditional credit such as the utilities, rent, cell phone, etc. to count towards the trade line requirements. In a situation like that underwriters want to see positive traditional trade line history after the negatives.

Re: Evaluating Conventional vs. FHA (VA & USDA)

If someone has a credit score in the low 800's, total debt to income ratio of ~20% (with current mortgage or ~33% with potiential new mortgage) , around 21% down payment and another 14 months worth of mortgage in the savings; which would be the best deal for a 30 year mortgage? Would a conventional loan work best? Becasue it sounds like it might be...

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